5 Things to Know About Farmland Appraisals
The following is an article written by Seth M. Baker for the May issue of Prairie Farmer Magazine. The article can be found on-line HERE.
Farmland appraisals are often misunderstood. From the legal requirements to the different valuation processes, there are many factors that go into every appraisal. A lack of understanding can result in confusion as to when an appraisal is required. Here are five things to know for understanding farmland appraisals.
Fair market value
Fannie Mae states, “fair market value (FMV) is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus.” An appraisal is the determination of that value. Emotions are often a factor in what a buyer is willing to pay, especially with farmland, and an appraisal removes that emotion.
Price does not equal value
Warren Buffett is quoted as saying “price is what you pay, value is what you get.” Why would a lender need an appraisal for a farm that was just purchased at auction? The final bid is what it’s worth, right? Not necessarily. If two neighbors battle over a tract of land at auction, the final selling price could easily exceed the fair market value. The bank needs to know what that farm is worth if that specific buyer was no longer in the market.
Watch the Date
In an estate, the appraisal is based on the date of death of the owner. Estates can often take 12-18 months to settle before ownership is transferred. If the new heirs use the estate appraisal to determine a selling price, they may be basing their decision on market data that is up to two years old. That can be a costly mistake. During the last run-up in farmland values, using a year-old appraisal could have cost a seller 20% or more.
A BPO is not an Appraisal
A broker’s price opinion (BPO) is not an appraisal. A broker’s role is to provide service and advice to clients to meet their selling/buying needs. Whether a land owner wants to get the best price, sell quickly, or a mix of other factors, a BPO will reflect the expectations of meeting those specific goals. Using a BPO when an appraisal is required can result in trouble for the landowner. If a landowner uses a BPO for tax purposes, the IRS can penalize the taxpayer if there is an audit. If the IRS believes the BPO resulted in an underpayment of taxes due, the penalties can be significant.
Farm Buildings
The buildings on farmland are likely worth less than you think. Utility does not determine value. Grain bins older than 10 years old can still have good use for grain storage for years in the future, but in some markets, they will likely add little value to the overall property. Brand-new machine shed? Sorry, even new, machine sheds can lose 25-30% of their value as soon as they are built.
Summary
Farmland appraisals play an important role in farm ownership. A good understanding of the appraisal approach can smooth the transaction associated with the required appraisal and provide piece of mind to the landowner.